Big firms shift newer assets to the experts

Whether to seek external sub-advisers to manage clients’ assets is always a tough decision for a firm to make, but the desire to enhance product offering to clients and the pressure for cost efficiency are driving banks and insurance companies to increasingly focus on their core investment competencies. Breaking that psychological barrier that can still prevent them from resorting to external providers, firms’ decision-makers are acknowledging that they cannot be good at managing all asset classes in-house.

In fact, the current credit crisis has highlighted that even asset classes usually regarded as safe and uncomplicated to run, in reality can be fraught with difficulties and hazards.

“Take fixed income for example,” says Alex Fletcher, head of Goldman Sachs Asset Management (GSAM) sales for Europe, Middle East and Africa (EMEA). “Managing a portfolio of fixed income securities is traditionally regarded as a pretty straightforward exercise, but the market turmoil of the last few months has demonstrated that it is not a straightforward exercise at all.”

Combined with an ever increasingly complex range of instruments available and permitted to be used, this is making firms reconsider whether they want to manage these assets themselves or whether they want to outsource them, says Mr Fletcher, referring to the wider range of investment powers allowed by the Ucits III legislation.

The fixed income universe has evolved rapidly over the last four years, explains Nick Phillips, head of third-party distribution in EMEA at GSAM. Whilst before, the objective was to deliver 50 or 75 basis points over the benchmark, now today’s more sophisticated fixed income targets the benchmark plus 250 to 350 basis points.

In order to achieve those returns and diversify a portfolio, it is necessary to blend together a number of asset classes such as currency, duration, credit, high yield or emerging market debt. The interest in this multi-strategy fixed income is definitely growing, says Mr Phillips. But the skills required within all those different sectors and knowing how to blend them are actually quite difficult to achieve, he says.

Current difficult conditions prevailing in the equity markets can also partly explain why hedge funds of funds have accounted for the majority of total new assets sub-advised by GSAM in the past 12 months, explains Mr Phillips. “Whether it would be a pension scheme or a private banking portfolio, over the last five years we have seen the amount that goes into funds of hedge funds rise and rise,” he says. “In addition, it may simply just be that this year, as equity markets are having a difficult period, total return products are proving very popular,” he says.

BEST MANAGERS MADE AVAILABLE

To meet growing demand for this asset class, whether it is to manage fully a portfolio of hedge funds or just provide an advisory service and access to different hedge funds, GSAM has created an internal fund of hedge funds platform. Here some of the best managers within a certain strategy are selected and made available to use. “This platform enables us to use the managers to create bespoke portfolios for our clients on a quick and efficient basis,” says Mr Phillips.

An asset class which lends itself to be sub-advised and is also drawing investors’ attention is active managed currency, explains Mr Phillips.

Often clustered in the hedge fund area as a global macro strategy, currency is a very liquid market and has become increasingly important. The presence of non-profit entities, such as governments or corporations, operating and investing in the currency world makes the analysts’ work interesting and challenging.

“We have a universe of 38 currencies and we are assessing the relative strength or weaknesses of each individual currency. We will go long one currency and short another, using typically currency forward contracts,” says Mr Phillips. “People have realised that currency is a proper asset class, where managers can generate alpha.”

However, of the total assets that GSAM currently manages globally in sub-advised mandates, the biggest proportion remains in equities.

There is still a huge demand for traditional long-only equity, explains Mr Phillips. In addition to Europe, US and Japan and emerging markets such as Bric (Brazil, Russia, India, China), there is also a growth in newer asset classes, such as water, infrastructure or agricultural commodities. “Product manufacturers and distribution businesses want to have [these newer asset classes] in their product offering, and private bankers want to talk to their clients about these more tangible asset classes. Investors understand exactly what the theme behind them is, as they are reading about these stories and understand what’s happening in the world,” he says.

The emergence of specialised boutiques that keep on winning very specialised mandates, also for these new thematic areas, does not worry GSAM sales managers too much.

Being able to provide a wide range of products is not really a differentiating factor, as it is excellence in the specific asset class under consideration that really matters for clients, explains Mr Fletcher.

“We will only be successful if we offer excellence,” he says. “But you could build up a good argument for contracting with a large, well-known entity who offers excellence before you contracted with a small unknown entity who offers excellence,” he says. Stability and brand therefore do count. After all, the brand is only created as a result of what a provider has achieved in the past and its good track record, says Mr Fletcher.

Long term investment decisions

The huge wave of redemptions seen in the European fund industry has not had a big impact on the sub-advisory business at GSAM. Despite market depreciation, sub-advised assets increased by 8 per cent in 2007 to ?40.8bn, following a growth of 45 per cent year-on-year in 2007. Although GSAM’s net funds sales have also been positive, says Mr Fletcher, the nature of the sub-advisory business, which involves more of a long-term strategic decision, contributes to make sub-advisory assets more stable.

This is also a consequence of the nature of firms that tend to sub-advise, explains Mr Fletcher. “Our client mix is more oriented towards insurance companies and end users will have probably bought these sub-advised funds as a part of their long-term savings plans,” he says. Investors’ longer time horizons make these assets, therefore, less susceptible to short-term price movements.

“Multi-managers may have more pressure on them than longer term savings plans but the people we deal with understand what we are trying to achieve. I don’t think this [market volatility] has created undue short-term pressure,” he says.

Volatility can also create opportunities, as it becomes possible to identify cheap and good value companies or fixed income securities. “These difficult conditions lead people to become very careful about what they do,” says Mr Fletcher, adding that good managers are benefiting from that. Last year, GSAM came third of all the offshore managers in terms of net sales, including cash products, he explains.

Geographical focus

The fund crisis that has hit some countries more than others has not affected the geographical focus at GSAM. Targeting and servicing cross-border global firms on one hand, and dominant local entities on the other, in Italy, Germany, Spain, France, the Netherlands, Scandinavia and Switzerland, as well as the UK, remain the two pillars of the firm’s business philosophy.

“We are increasing the number of people we employ in Italy, in Germany, in the UK and those covering global distributors,” reveals Mr Fletcher. “The new tax legislation may make Germany attractive for funds distribution but in each of the others, sub-advisory is just as likely to be a beneficiary of that as fund sales.”

Despite the Italian fund system having lost over ?50bn from the beginning of the year, Mr Fletcher remains undeterred. He has “big hopes” for the Italian market.

After all, the sub-advisory model is just a different model to selling funds, says Mr Fletcher. It is more of an institutional model, the assets are longer term and stickier.

“Peaks and troughs in sub-advisory are lower than the peaks and troughs in mutual fund distribution, but we want to be in both, and by combining these two segments with our pension fund business we get a very good blend,” he adds.